2013 Economic Outlook: another disappointment or the start of a sustained recovery?

By Andrew Smith, chief economist, KPMG in the UK

2012 proved disappointing for most advanced economies as unemployment remained stubbornly high and output wavered between expansion and contraction. Any improvement in 2013 will depend as much on political considerations as economic fundamentals.

The threat of a Greek exit from the euro dominated headlines for much of the year, but the authorities, for now, have shown signs that they are prepared to do what is needed to keep the currency zone intact. That said, the situation remains precarious and the eurozone economy is in recession again. The European Commission has cut its growth forecast for 2013 to 0.1 percent – hardly growth, let alone a recovery – and two of the four largest economies are likely to continue contracting. France and Germany may skirt recession but growth will be meagre at best.

Finding a lasting solution to the problems of high levels of indebtedness in the peripheral economies and their relative loss of competitiveness is proving politically difficult. So for now, Europe has adopted a de facto policy of muddling through. This could continue for some time. But ultimately a choice will have to be made – or the risk is that one will be forced on the continent by the financial markets. 

The US has perhaps the brightest prospects of all the major advanced economies. But this optimism could prove short-lived.

In pure economic terms there is evidence the worst may be over. The housing market recovery has picked up steam, unemployment is dropping and banks are showing an increased willingness to lend. But it may ultimately be politics that determines the path of the American economy in 2013. At the close of 2012, the “fiscal cliff” looms large. If no action is taken in Congress, mandatory budget cuts equivalent to around 4% of GDP will be enacted from January. These measures would almost certainly send the country back into recession – to that end it is in neither party’s interest. Common sense should prevail – but brinkmanship increases uncertainty and regardless of the outcome business and consumer confidence has already been damaged.

The UK is not without its policy challenges either. Those arguing for a slowdown in the pace of deficit reduction have become increasingly vocal as growth has persistently disappointed. Technically the double-dip recession may have ended with the bounce-back in activity over the summer, but output in 2012 overall will come in pretty much flat. The Office for Budget Responsibility’s forecast for the coming year is an improvement, to about 1.2% – still well below the pre-crisis trend.

The weak economy is itself frustrating the deficit reduction strategy and ratings agencies have responded by threatening the UK’s triple A rating. Should a downgrade be forthcoming, however, it will most probably excite the politicians but do little to alter the view of the markets. 

The real economy is still in the shadow of the financial crisis. Over-indebted consumers are saving rather than spending, and faced with huge uncertainty, businesses are sitting on cash rather than investing. So public sector cutbacks are reinforcing private sector retrenchment in constraining growth. At the same time, the global slowdown, in particular recession in Europe, severely limits the scope for exports to come to the rescue.

More positively, in the personal sector balance sheet repair is underway, employment is rising and the squeeze on real wages, which has been a major factor in holding back spending, may be starting to ease. However, “austerity” means what it says on the tin, and without a change in policy, getting even the weak growth which the OBR has pencilled in for 2013 may require further stimulus from the Bank of England.

Elsewhere, the pace of expansion of many emerging economies has slowed as a myriad of domestic challenges coexist against the backdrop of troubles in the West. Falling high-end property prices and concerns over its export markets led to fears during the middle of 2012 that China was facing a hard-landing – such worries now appear to have been overdone as the authorities have demonstrated a willingness to use the fiscal and monetary tools at their disposal. Data from India is less reassuring but the economy should have a better 2013 than 2012. And whilst growth has decelerated, it has not stalled. Once again the IMF expects the emerging markets, more generally to take the lion’s share of world growth.

And we mustn’t forget Japan. While currently struggling, it is still the world’s third largest economy and hopes are high that a new Government will sanction aggressive stimulus measures.

So the world stumbles on. Whether 2013 proves to be another disappointment or the start of a sustained recovery remains to be seen.

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